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Friday, November 16, 2007

The Asymmetric Effects of Monetary Policy: Texas vs. Michigan

In several previous postings (here, here, and here) I have commented on the stark contrasts between the economies of Michigan and Texas. Part of my motivation for making these posts was personal. I was trying to sell a home in the depressed Michigan economy after moving to a new job in the vibrant Texas economy. Another motivation, though, is that a colleague and I have been working on a paper (for the SEA meetings in New Orleans) on the asymmetric effects of monetary policy. Specifically, we are looking at the differential impacts of monetary policy shocks across the contiguous 48 states for the period 1979-2001. We follow some previous work done on this topic--see Ted Crone's survey--but add some innovations along the way.

One of our findings, consistent with that of the earlier research, is that monetary policy shocks have a non-uniform impact across the state economies. Monetary policy shocks are particularly poignant in the Great Lakes region while they largely uneventful in the Southwest regions. Of course, my previous Texas-Michigan discussions fall nicely into these two camps. So from our paper, I have posted below graphs that show the typical response--the solid lines--of real economic growth on a monthly basis for these two economies from a typical monetary policy shock. I have also included the typical U.S. response as a benchmark. Standard error bands, which help provide a sense of precision of these estimates, are shown by the dashed lines. (Technically these graphs show the impulse response function from a near-vector autoregression of the growth rate for each state economy, as measured by the coincident indicator, to a standard deviation shock to the federal funds rate.)

The differential responses of these two states to the same monetary policy shock are striking. Texas is hardly affected relative to the steep downturn in Michigan. As noted above, these patterns fall more broadly into the regions of the United States with different sensitivities to the federal funds rate shocks. Our research confirms early studies that show these regional differences can be partly explained by the composition of output: those states with a relatively high share in manufacturing get hammered by a monetary policy shock while those states with relatively high shares in extractive industries fare much better. We also find that states with a relatively high share in the financial sector fare better as well. Finally, we find that states that have (1) a relatively high share of labor income compared to capital income and (2) a relatively high rate of unionization also get hammered by monetary policy shocks.